Markets & Finance

IPOs: On the Comeback Trail


The pace of offerings is picking up, with financial and health-care issues leading the way. But the market still lags its 1999-2000 glory days

From Standard & Poor's Equity ResearchThe pace of new listings on U.S. exchanges has accelerated to its fastest rate since the hectic days of 1999 and 2000. This year through Apr. 17, there were 55 initial public offerings on U.S. exchanges, an 8% gain from the year-earlier period, according to Renaissance Capital, an investment adviser specializing in IPOs. Seventy-eight IPOs have been filed with regulators so far this year, a 13% rise.

However, the IPO business has a long way to go before it can match the frenetic pace of the boom years of 1999-2000. Linda Killian, portfolio manager of the IPO Plus Aftermarket fund (IPOSX), points out IPOs are in a slow recovery from the depths of the 2001-2003 bear market.

In 2006, there were 198 IPOs in the U.S., amassing proceeds of about $43 billion. There were 194 IPOs in the prior year, raising $34 billion. While these numbers are increasing, they pale in comparison with the halcyon days at the cusp of the 21st century; 486 IPOs hit the market in 1999, generating $93 billion in proceeds, followed by 406 offerings in 2000, garnering $97 billion.

Radically Different

Then, as the market crashed, so did the IPO business. From 2001 through 2003, the number of IPOs issued declined to 68 from 83. Proceeds fell to a paltry $15 billion from $41 billion.

Killian thinks it will take several years for the IPO market to return to a normal rate of annual issuance. "I think that an average year for IPOs is 250 deals, so we're still below that," she says. "We can return to a healthy IPO market when investors feel they will be rewarded for buying new companies." Killian notes that in 2006, IPOs fell into two divergent camps: growth and yield. She says the traditional IPO growth sectors of technology and health care were more active than in 2005.

The average IPO returned 26% last year. IPO proceeds in 2006 were inflated by seven deals valued in excess of $1 billion. MasterCard (MA) ranked at the top in terms of volume ($2.4 billion).

The IPO business is radically different now from the speculative period of 1999-2000. For example, the average first-day return for IPOs amounted to an astounding 72% in 1999 and 56% in 2000. By 2006, that figure came down to 11%. Another dramatic difference: In 1999 and 2000, the majority of companies going public were unprofitable. In 2006, about 75% of the companies were profitable.

Tech Crush

The IPO world of 1999-2000 was filled with dozens of dot-coms and human-genome companies, most of which have since vanished. Over the past 12 months, financials have accounted for the most IPOs (18.8%), followed by health care (17.8%), energy (16.3%), and technology (15.8%).

"The fact that financial-services companies accounted for nearly 19% of IPO activity in the past 12 months isn't a surprise, considering that this sector accounts for more than 20% of the total market," says Cathy Seifert, head of financial institutions equity research at S&P. Seifert notes that recent IPO activity included a number of large deals. In the future, the deal composition might be smaller, on average, she says.

Technology generally represents from 16% to 20% of all IPOs, Killian says. In the mid-1990s, technology represented as much as 40% to 50% of the IPO market. "These things go in cycles," she notes. "It all depends on underlying demand and technological innovation. What's happening now is that tech IPOs—after being in the doghouse with investors for several years—are returning to favor." On average, tech IPOs gained 37% in 2006.

Vonage's Hangups

"We believe that positive investor sentiment related to the technology sector has contributed notably to more associated IPO activity," says Scott Kessler, head of technology equity research at S&P. "Broadband communications, wireless technologies, and related content and applications appear to be major IPO themes for 2007." Indeed, two of the top-performing IPOs from last year came from technology: Riverbed Technology (RVBD), a networking-equipment company, which nearly tripled in value, and Isilon Systems (ISLN), a data storage device company, which surged an eye-popping 77% on its first day of trading.

Among the worst-performing IPOs in recent memory, Vonage Holdings (VG), a provider of Web-calling services, plunged about 81% from its first day of trading last May through Apr. 17.

Before the offering, critics of Vonage cited the company's mounting losses, inability to turn a profit, and rising competition from bigger, deeper-pocketed rivals, among other woes. After Vonage went public, its CEO quit, its workforce was reduced, its budget was trimmed, and it lost a patent dispute with Verizon (VZ).

Killian cautions that while investors are now generally more receptive to tech-related IPOs, companies in the sector must be looked at on a case-by-case basis.

A Gusher in Energy IPOs

Biotech companies that began operations three to five years ago now have drugs in advanced clinical trials. "This is the stage when public investors are willing to take a look at these companies," she says. The best-performing IPO over the past year was a biotech company: Omrix Biopharmaceuticals (OMRI), a maker of human plasma products. The stock was initially offered at $10 in April, 2006.

With oil prices remaining above $50 a barrel, "we have seen new public offerings across the broad energy sector, including explorers, services, refiners, as well as alternative-energy names," Killian says. "With crude prices at record levels and interest rates relatively low, investors sought yield and underwriters obliged, churning out large numbers of energy and tanker partnerships geared to individuals."

Of the 10 largest IPOs last year, four, including auto rental company Hertz (HTZ) and Spirit Aerosystems (SPR), were made by private equity companies. "In the majority of private equity deals, the lead investor does little but leverage the company to pay a hefty insider dividend, and the performance of the IPO is deservedly mediocre," Killian observes.

Mild Climate

The IPO fund she runs is the only one of its kind, and Killian has overseen it since its launch in late 1997. Since it can participate in first-day offerings, this mutual fund is one of the few ways retail investors can get a crack at this type of investment.

Looking ahead, Killian expects to see more private equity issuers involved in IPOs. "Buyouts have increased in frequency in 2006, and since the private-to-public turnaround is increasingly short, we expect to see many more of these leveraged offerings," she says. "As far as the larger environment is concerned, the economic and political landscape is largely benign. A climate of relatively low interest rates and slowing GDP [gross domestic product] bodes well for IPOs."


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